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Japan does not demonstrate the failure of stimulus

When I read Ed’s recent piece “Japan: stimulus without reform leads to a policy cul de sac,” I couldn’t help but think he is wrong about Japan.

Supporting aggregate demand

The problem is taxes. In Japan, taxes are too high relative to the desire for spending and savings. Policy makers need to stop taking so many yen away from working people, so that they are able to buy all of the output which they can produce at full employment levels.  

The Japanese should have gone for domestic demand-led growth instead of export-led growth. When export growth reversed, the economy went into depression. Even Richard Koo, who has often spoken of a balance sheet recession and has the right approach on Japan, never imagined that such a thing would happen.  But it’s easy enough to resolve; simply support domestic incomes with the right tax cuts to sustain domestic demand at desired levels to sustain output and employment.

One can always sustain domestic demand by altering the fiscal balance.  In truth, it is as simple as debiting and crediting accounts on the Bank of Japan’s master yen account spread sheet.

Again, a fiscal adjustment can restore domestic demand immediately.

Savings in Japan

The savings rate in Japan is down as a consequence of falling net exports and what was until recently a falling budget deficit. The deficit trend is now reversing in a very ugly way- falling revenues and increased transfer payments.  True, private sector savings have fallen which means that Japanese policy makers have run out room for error.  I would contend that the vast scale of private savings allowed them to continue to screw up for so long by, for example:

  • hiking the VAT in 1996
  • introducing ‘fiscal consolidation’ in 2001 (and finally relenting in 2003 when the economy finally started to grow again, until this latest fiasco). 

Issuing one’s own fiat currency debt

But, the notion that the country is in a ‘debt trap dynamic’ as Ambrose Evans-Pritchard suggests is ludicrous.  Debt is serviced by data entries by the BOJ- debits and credits to securities accounts and transactions accounts at the BOJ. The BOJ can spend/credit accounts at will.  It’s just data entry.  Spending is not constrained by revenues (this is fiat currency, not a gold standard). In a worst case, ‘over-spending’ causes inflation. But, that happens to be what they are trying to accomplish. Getting some inflation would be considered a success.  Moreover, it can easily be reversed by tightening fiscal policy if it comes to that.

It’s really that simple.

Marshall Auerback

About 

Marshall Auerback, has 29 years experience in the investment management business, serving as a global portfolio strategist for Madison Street Partners, LLC, a Denver based hedge fund. He also has also worked as an economic consultant to PIMCO, the world’s largest bond fund management group. He is a Fellow at the Economists for Peace and Security, a Research Associate at the Levy Institute, and a non-executive director of Pinetree Capital in Toronto, Ontario, Canada.

13 Comments

  1. Anonymous says:

    Marshall – I disagree with you that Sovereign Debt cannot be a problem.

    Surely the ability of The Government to pay-off/reduce its (JPY) debt is limited to:
    i) The Amount of Tax Revenue that the Government can obtain from the citizens
    ii) The Amount of debt that the Government can ‘print’ – which is in its own currency.

    There is a maximising (and presently unknown) Tax Rate above which The Government will not be able to gain more money. A self-reinforcing point could be reached where Tax Income is insufficient to reduce Total Sovereign Debt and The Government is forced to finance itself by Ponzi-Financing in an increasing interest environment. Public Spending will have to be slashed, but this may not be sufficient.

    In the West, The Private Sector was able to perform Ponzi-Finance in a declining interest rate environment – thanks to the Fed. With Interest Rates ,especially now, at zero there is a Debt Limit for Sovereign Debt above which this self-reinforcing Ponzi-Finance will be reached – i.e. where Tax Income (Revenue Less Expenditure) is insufficient to reduce Outstanding Debt in a rising interest-rate environment.

    With countries like Zimbabwe – which do not have effective Taxation regimes or sufficiant revenue flows – this problem simply occurs earlier.

  2. Jo says:

    I agree with fuquez – what’s being posited here is simply ridiculous.

  3. Anonymous says:

    Let me clarify. I agree that Government Spending is not constrained by Revenues; but that does not mean that Issuing Bonds either to The Public or effectively through The Central Bank in a rising interest rate environment is not, or cannot be, a problem.

    Mynsky’s Hedge, Speculative, & Ponzi Finance regimes can be applied to Sovereign Debt, but the end result is Inflation/HyperInflation and not Deflation.

    If the Private Sector has estimated that it would be unable to produce the economic output to re-pay the debt via pre-tax revenues and looks to deflation and default; I do not understand what concern it is of The Government to take these very obligations on board and attempt to solve the problem via its tax revenues.

    Our fiat currencies are backed by the future taxation of our productive enterprises – this has an NPV limit as much as a store full of gold and silver. This limit may be harder to calculate but when the financing flows cannot be maintained to service the assumptions that these can be repaid we go ‘critical’. Instability will occur at this point.

    • Give me one example in history of a country with a freely floating non-convertible exchange rate, issuing debt in its own currency which has had a national solvency problem. You can’t because there isn’t any. There is no coherence on this score.

      You can’t use emerging markets as examples, because they generally had high foreign debt components, or pegged rate or currency board systems. There is no solvency issue in the kind of circumstance I am discussing.

      I’ve heard the “Ponzi” scheme analogy endlessly. Remember, a government creating its own currency doesn’t have the constraint that a Ponzi scheme has. Additionally, that interest being paid out is going into debt holders’ pockets. It actually operates in a manner akin to a “fiscal channle” (Bernanke wrote about this in 2004). You can’t focus solely on the liabilities of the government, but the assets of the private households on the other side of that integrated balance sheet.

      Best,

      Marshall Auerback

      • Anonymous says:

        Marshall I cannot. I also did not mean to say/imply that it would default.

        I am simply saying that one end to an increasing debt and tax revenues unable to reduce the burden in an increasing interest rate environment is hyper-inflation – i.e. the collapse of the currency system. No default, but hyperinflation.
        I am convinced that there is a combination of Debt, Tax Revenue & Expenditure and Interest Rates where this becomes self-reinforcing and unpreventable.

        I remember on another blog a mention to the 1998 Rouble Crisis, but am not sure of the history behind that.
        I will investigate that and the ‘fiscale channle’.

        Thanks

        • See my subsequent comments, which I think more directly address your point: Japanese households DO NOT FUND THE DEFICIT. A government default is not possible (unless Japan chooses to do it, which I suppose they could do as they are pretty clueless).We learned that interest rates do not sky-rocket and inflation does not accelerate when deficits and debt issuance are on-going and huge – quite the opposite. If the BOJ should want to increase the money supply, devotees of the money multiplier model (including numerous Nobel Prize winners) would have the BOJ purchase securities. When the BOJ buys securities reserves are added to the system. However, the money multiplier model fails to recognize that the added reserves in excess of required reserves drive the funds rate to zero, since reserve requirements do not change until the following accounting period. That forces the central bank to sell securities, i.e., drain the excess reserves just added, to maintain the funds rate above zero. If, on the other hand, the BOJ wants to decrease money supply, taking reserves out of the system when there are no excess reserves places some banks at risk of not meeting their reserve requirements. The BOJ has no choice but to add reserves back into the banking system, to keep the funds rate from going, theoretically, to infinity.
          In either case, the money supply remains unchanged by the BOJ’s action. The multiplier is properly thought of as simply the ratio of the money supply to the monetary base (m = M/MB). Changes in the money supply cause changes in the monetary base, not vice versa. The money multiplier is more accurately thought of as a divisor (MB = M/m).

          In a message dated 04/11/2009 Mountain Standard Time, writes:
          fuguez wrote, in response to mauerback:

          Marshall I cannot. I also did not mean to say/imply that it would default.

          I am simply saying that one end to an increasing debt and tax revenues unable to reduce the burden in an increasing interest rate environment is hyper-inflation – i.e. the collapse of the currency system. No default, but hyperinflation.

          I am convinced that there is a combination of Debt, Tax Revenue & Expenditure and Interest Rates where this becomes self-reinforcing and unpreventable.

          I remember on another blog a mention to the 1998 Rouble Crisis, but am not sure of the history behind that.

          I will investigate that and the ‘fiscale channle’.

          Thanks

          Link to comment: http://disq.us/2ztp9

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        • Anonymous says:

          In Japan, households DO fund the deficit, at least indirectly, since a large percentage of household savings goes into postal savings accounts, which is then used to buy BOJ notes.

          In response to the first line of your article, the major problem with saving in Japan is houses, not taxes. Houses in Japan are depreciating assets which typically are torn down and replaced after their 30 year life span runs out. Instead of being able to invest and build equity in a house, the Japanese know that if they are told to relocate by their employer they will not be able to sell the house for what they paid. As a result, they need cash available to pay off the difference between the current value of the property and the loan, as well as a down payment for another property.

  4. Andy says:

    I agree with Fuguez

    The Japanese population is getting smaller every year, and there will be NEGATIVE GDP growth in the long-term. How can a smaller tax base support interest payments and repayments for a government debt that is the largest by far in the world, and is forecast to keep on growing??

    Of course, the government could print money pay off the debt, but there is very little PRODUCTIVE spending that they can embark on. Japan is already a very wealthy developed nation with world-class human and physical infrastructure. And since the population is DECREASING and AGEING, most of that spending would actually be WASTED, and would not contribute to any long-term growth.

  5. Spending is not constrained by revenues? But isn’t that the problem?

    Right or wrong, it is apparent that our current administration would agree with you – we can spend/credit/print our way back to prosperity! Just like Argentina.